The Broadbent Blog

Public investment can boost growth and reduce public debt

With the federal budget set to return to balance this fiscal year, we can once again debate how to deal with future surpluses. Priority could be given to paying down the debt, cutting taxes, or re-investing in public services and social programs.

These options should be judged on how much they contribute to a stronger economy as well as a fairer and more inclusive society.

The Conservative fiscal plan, to be enshrined in promised balanced budget legislation, is to continue to run small surpluses while cutting taxes.

Finance Minister Joe Oliver recently wrote that, “balanced budgets require a plan and the discipline to follow it.... I said that debt as a percentage of GDP will decline as the economy grows, which is a statement of fact, on the obvious assumption that we balance our budgets.”

It is not, in fact, necessary to balance the budget each year in order to reduce the public debt as a share of the economy. The debt will fall so long as it grows at a slower pace than the economy, as was the case in the last fiscal year, 2013-2014, when the federal debt fell from 33.5% to 32.5% of GDP despite a deficit of $5.2 billion.

The Harper government has clearly said that, while balancing the budget, they will deliver promised tax cuts in the form of family income splitting and a doubling of contribution limits for Tax Free Savings Accounts, once surpluses emerge.

Some prominent business voices, including the Conference Board of Canada and the Canadian Council of Chief Executives, are calling on the federal government to run surpluses to reduce debt at an even faster rate.

However, there is a growing consensus, even in the most conventional economic quarters, that spending more, in the form of increased public investment, could reduce public debt even more rapidly than balancing the budget or running surpluses.

The International Monetary Fund – usually associated with calls for strict fiscal discipline – recently released a major study arguing that, in the current context of a very weak global economy and record low interest rates, well-selected public infrastructure investments can boost growth and jobs and reduce public debt.

“In a sample of advanced economies, an increase of 1 percentage point of GDP in investment spending raises the level of output by about 0.4 percent in the same year and by 1.5 percent four years after the increase. In addition, the boost to GDP a country gets from increasing public infrastructure investment offsets the rise in debt, so that the public debt-to-GDP ratio does not rise.”

The study adds that, “evidence from advanced economies suggests public investment that is financed by issuing debt has larger output effects than when it is financed by raising taxes or cutting other spending.” In other words, running deficits to finance productive public infrastructure investment can actually lower the debt more than running balanced budgets.

Former federal Deputy Minister of Finance Scott Clark and his colleague Peter DeVries have lauded the IMF study, and called on the federal government to run modest deficits to help finance much needed local and provincial infrastructure spending.

As they further note, the tax cuts promised by the Harper government will do nothing to boost short and medium term economic growth. Nor, one can add, will they do much for fairness given that family income splitting will mainly benefit upper income families with a traditional stay at home spouse, at an annual cost of some $3 billion.

To put the question of our fiscal choices in a broader context, Canada, having run budget surpluses for a decade from 1997 to 2008, is in by far the best fiscal position of any major economy. Net government debt is just one half the G7 average.

Over the decade of surpluses, the Liberals also cut federal taxes as a share of GDP by one percentage point, and the Conservatives by another two percentage points. This amounts to foregone annual revenues of almost $60 billion.

Meanwhile, federal program spending has been frozen since 1997 as a share of GDP, except for a blip to fight the recent recession which has now been reversed.

Canada can unquestionably afford to spend more, not just on public infrastructure, but also on social priorities such as child care and early learning, health care and pharmacare and affordable housing, as well as on clean energy, the environment and economic renewal.

Hopefully we will see a real public debate over our priorities in the run-up to the critical 2015 federal budget.

And let us bear in mind that balanced budgets and tax cuts are not the only fiscally responsible option.

Andrew Jackson is the former Packer Professor at York University and senior policy adviser to the Broadbent Institute.